It has been reported recently that credit card debt is falling, which we are told is a clear sign that the financial situation of consumers is improving. These reports emerge from the data released by the Fed, showing that revolving credit on the books of financial companies is falling. But these figures could be misleading.
First of all, it seems strange that credit card debt could be falling when employment is hovering close to 10% and job cuts are still coming thick and fast from almost all industries. If people are losing jobs, how could they be happily paying off their credit card debts? The fact is that even if people want to pay off their debts, in the current economy they simply can’t afford it.
Another important point is that credit card interest rates were hiked significantly last year. This means that interest payments being made by consumers have gone up. So the proportion of payments going into debt repayment would have fallen, as a larger chunk goes into paying interest.
Some analysts argue that revolving credit numbers are falling because of charge offs by banks and not by consumers paying off their debts. Every time a credit card debt goes six months without payment, it has to be ‘charged-off’, which means that as the bank has very little hope of recovering that money, it should be removed from its books. This charge off is mandated by law as it shows the true financial situation of a company in terms of which debts it can expect to be repaid and which it might have to forego.
These charge-offs directly hit the profit and loss account of a financial company. So the charge-off theory is consistent with the losses that consumer finance arms of banks have continued to show even as the economy has recovered to some extent.
There are a lot of people who are of the opinion that these increased charge-offs are caused by the banks’ own irresponsible policies. By increasing interest rates, using customer payments to offset low interest debt instead of high interest one, and poor risk assessment of customers applying for credit cards have all led to a situation where a huge percentage of customers are finding it difficult to repay their credit card debts. The CARD Act has tried to deal with many of these questionable policies, but it is yet to be seen how effective the legislation will be.
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